Forex Trading Method

Scientific Method

Forex currency trading is a science and those who are going to prosper will need to treat it as such. In this section, we shall investigate the underlying principles of a scientific forex trading using the scientific method. We shall also dip into its relationship with chaos theory. The scientific method is based upon two principles:

1. Empiricism – this involves the gathering of observable information and experimentation.
2. Induction – this involves providing the best explanation for the information gathered.

As a science, currency trading appears to be more like biology rather than physics. For example in physics, the speed of light is 299792458 metres per second and is generally treated as a fixed number. However when investigating bacterial growth in biology, scientists adopt a more statistical approach, they are interested in the accumulative effects of millions of tiny bacteria rather than observing just one entity. (One could point out that light is actually a large body of photons and as a consequence the speed of light is a figure based on statistical analysis… but that would be making the analogy unnecessarily complicated!)

This is what takes place in the study of currency trading; many people are trading at any point in time and they are trading for specific reasons. We as traders do not seek to understand why one person traded, rather we need to gain a general inclination from a whole body of people where they believe that the graph should go and why. Trading decisions are normally influenced by two basic elements; the fundamental data and human responses to that data.

As fundamental data is released, this becomes the most influential contribution to the direction of the graph. However, over time and the absence of new data, human responses become more influential. The interaction between fundamental data and human responses leads to currency trading being actually quite complicated.

Chaos Theory
Chaos Theory explains the behavior of systems where the final solution of an entity running in real time cannot be written as a linear sum of its independent components. The final solution is highly sensitive to the initial components, which can provide an exponential contribution to the conclusion. Chaotic systems appear to behave randomly although their final result can be aptly explained by the initial components. The classic example is found in the idea that a butterfly could flap its wings in one part of the world that eventually leads to a hurricane in another part of the world.

In his book on trading, Williams argues that, ´Chaos theory stands in stark contrast to analytical theory´ (p. 24). He continues, ´The classical approach to both science and the analysis of markets contains too many filters, stiff perspectives, and levels of intersubjectivity to teach us what is really going on ´out there´.´ His arguments lead him to adopt an alligator method of trading. I would suggest that Williams has limited his definition of science to what he calls ´classical´ science and as a consequence he inevitably finds flaws with a method that is between 500 and 2500 years old. The reality is that both scientific and chaos perspectives can contribute to a good trading model.

While it is true that the trading graphs bear many hallmarks of a chaos driven system, yet at the same time, they are also influenced by fundamental data. Also inductively based technical analysis can reap fruit in producing an effective trading method, leading to the conclusion that there is no ultimate confliction between chaos theory and the scientific method in the context of forex currency trading.

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Bill Williams, ´New Trading Dimensions: How to Profit from Chaos in Stocks, Bonds, and Commodities´, A Marketplace Book.